Startup Equity Allocation: Why Your Idea Is Worth Nothing
Equity Valuation and Allocation
Equity allocation is an important concept to understand at the outset of your venture. Think of it as your company stock is a pie and you and your co-founders are trying to figure out how to divide the pie amongst yourselves.
This is actually a very important issue that comes up right at the beginning of a startup, but mostly gets glossed over because the startup has no value and you’re not even sure if your slice of the pie will ever be worth anything.
The Value of an Idea is in Its Execution
Execution has greater value than the idea. What do I mean by that? A lot of founder teams give way too much credit and, therefore, a lot of the company’s equity, to the person who came up with the idea for the company.
Obviously, ideas are very important, but they have zero value. The reality is no one has ever paid a billion dollars for just an idea. The value of an idea is in its execution. You, as a founder, need to resist that urge to give a disproportionate amount of stock to the co-founder who came up with the idea for the company.
So how much stock should be allocated between the founders? The simple answer is probably yes, allocation doesn’t have to be exactly equal, but if it is very disproportionate, that’s a huge red flag for lawyers and investors. They will wonder why the founders are not taking ownership or believing in the company. Theoretically, each founder should be contributing something to the execution that is different, but equally important. One founder might focus on marketing, while a technical founder focuses on building the platform, but they are both essential to the execution of the idea.
With disproportionate allocations, an investor is going to wonder: is one founder secretly thinking that this whole thing is a temporary, while another founder is overinflating the work that he or she has already done on the company or his or her education or prior experience?
The expectation is that in your startup each founder is in it for the long haul everything that happened before the formation of the companies shouldn’t matter. It doesn’t matter who came up with the idea, who built the prototype, or which one has an MBA. It will feel better to the whole team if the allocation is equal because the whole team is necessary for execution. IF you look at the top twenty companies, which are those with the highest valuations, not one has had a significantly disproportional founder equity split.
Another way to think about it is that each individual founder represents the company to the outside world equally. Regardless of equity split, each founder has the responsibility and duty. So, you have to think about how you are presenting yourself and how your co-founders are thinking of themselves in relation to the company, regarding ownership. If it’s wildly disproportionate, then they may not take as much personal responsibility which results in a messy situation.
One day, your goal is to grow your startup into a large company. If you want to be the next Google, you wouldn’t set a compensation package for some employees that has free meals, while others don’t. Employees would look around and say “what’s going on here?” Well, the same concept of fairness applies to your startup as well and it is very important.
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